north carolina supplemental retirement plans neuberger berman … · 2019-02-14 · february 19,...

North Carolina Supplemental Retirement PlansNeuberger Berman Large Cap Disciplined GrowthRetention ReviewFebruary 2014

MERCER 1

Summary and Observations

• Neuberger Berman was hired to provide a lower beta / higher quality portfolio to the largecap growth fund– Performance is expected to be better in down markets than up markets

• Neuberger Berman has a strong long term track record but performance has beendisappointing over last four years– Primary issue was mistakes in 2011– Team structure changes exacerbated mistakes

• Very tenured PM team (+20 Years together) and a long track record indicates more skill thanluck

• Mercer Assessment:– 2011 was likely an anomaly– 2012 and 2013 performance consistent with expectations– 2014 likely to be a “normal” year, with fundamentals driving results– We recommend retaining Neuberger, with action to be taken if they do not outperform

in a normal or down year

MERCER

Evaluating Managers on Watch ListProcess

• Objective: Evaluate confidence in manager’s ability to succeed in the future

• Watch List Manager Retention Evaluation– What is the manager’s process and philosophy– When should it be effective and when should it struggle– Is recent performance consistent with expected pattern of performance– Can the team execute the strategy successfully

- Is past performance indicative of ability or luck– Can the strategy succeed in the future

- Stable Team- Process and Philosophy expected to work- Process and Philosophy can be implemented by manager

2February 19, 2014

MERCER

Neuberger BermanPhilosophy and Process

• Growth oriented strategy seeking accelerating earnings growth driven by an identified catalyst

• Valuation discipline enhanced by requirement for attractive free cash flow yield

• Companies must have strong and conservative balances sheets, with ample liquidity tofinance growth

• Experienced management teams with proven ability to execute

• This philosophy should produce a portfolio that will– perform well in most market environments– will excel in down markets– struggle in exuberant markets

3February 19, 2014

MERCER 4February 19, 2014

2009

• Dramatic underperformance• Biased towards quality and

large cap• Risky and small stocks led

market• New PMs added to team.• # of stocks in portfolio begins

to increase to around ~65• turnover decreased

2011

• Lagged index by 6.3% in 2011• Poor stock selection• Underperformed significantly in 2Q11 and 3Q11

when quality was in favor• Netflix and Illumina were major detractors.

• 2012 underperformance was smaller and inline with process for a rising market

• PM team reduced to original 2 members in2012

• 2013 underperformance expected insharply rising market

• # stocks back down to <55, decisionprocess streamlining

2012/2013

Neuberger BermanPerformance Overview

Underperformance in 2009 and 2013expected, 2011/2012 were not expected.


Neuberger BermanLong Term Performance Cycle

MERCER

Team and Resources

Name Title Location Joined Firm Joined Industry

John J. Barker Managing Director, Portfolio Manager New York, NY 1994 1980

Daniel H. Rosenblatt Managing Director, Portfolio Manager New York, NY 1990 1981

Neil Groom Managing Director, Portfolio Risk Manager New York, NY 2004 1999

Dedicated Research Team 5 Team Members New York, NY > 16 Years Avg Experience

6February 19, 2014

KEY TEAM MEMBERS

History of Product Assets

Strategy headed by co-portfolio managers, JohnBarker and Daniel Rosenblatt.

1997-2007

Team moves towards a fourportfolio manager structure,promoting Larry Fisher andDaniel Fletcher. Portfoliodecisions had to beunanimous among portfoliomanagers. Client service wasone of the reasons for theteam expansion.

2009 2012

The team moved back to theco-portfolio manager structureas a result of poorperformance and a lessefficient decision makingprocess. Fisher and Fletcherretained their previousassociate portfolio managerpositions.

2012

Larry Fisher and NeubergerBerman mutually agreed topart ways. The team felt thatFisher did not react quicklyenough when ideas werebrought to him by analystsand was too risk averse.

MERCER

Neuberger BermanAsset & Rating History

7February 19, 2014

Date Assets($B)

Clients MercerRating

Comment

May 20091 $6.5 649 B+ Mercer initially rated theDisciplined Growth Strategy

November 20102 $11.6 641 A Mercer upgraded rating to “A”based on the impressive team and

investment process

September 2012 $10.5 530 B+ Mercer downgraded the fund to a“B+” due to the personnel changes

within the team as well asstructure change that took place in

2011

September 2013 $6.6 422 B+ Mercer reaffirmed the “B+” ratingon the strategy

1 Assets and clients as of June 30th 20092 Assets and clients as of December 31, 2010

MERCER

Neuberger BermanStrategy ProfileKey Decision Makers: The core investment team consists of co-portfolio managers Dan Rosenblatt and John Barker who arethe final decision makers. The investment team is supported by four research analysts, one portfolio risk manager, and oneportfolio specialist. Additionally, the team has access to Neuberger's centralized buy-side analysts.

Investment Style/Philosophy: The Large Cap Disciplined Growth team invests in companies with prospective acceleratinggrowth metrics (earnings per share, cash flow, or number of subscribers) driven by an identifiable catalyst. The team seekscompanies that have an experienced and accessible management team, ample liquidity, manageable leverage, and/or the abilityto generate both free cash flow and operating income growth over time. The team believes companies with these qualities havethe potential for price appreciation through earnings growth and an expanding valuation brought about by improved investorperception.

Investment Process: The initial step in the investment process is a simple quantitative screen to identify stocks with market-capitalizations above $3 billion and daily dollar trading volume greater than $100 million. Additionally, debt as a percent of totalcapitalization and price-to-earnings ratios for each respective industry group is considered. These screens typically yieldapproximately 400 companies. Fundamental analysis is then performed to identify potential catalysts that could accelerategrowth at particular companies. This typically reduces the field to approximately 150 names. Examples of identifiable catalystsinclude: new product development, regulatory change, management changes, mergers, acquisitions, demographic shifts andcorporate reorganizations. Next, the team analyzes the significance of the catalyst and quantifies its impact on a company'sgrowth. As a final step, the team will often meet with company management. The investment process typically produces five orsix companies at any given time that meet the team's criteria. While the dedicated team maintains ownership of the process, itsresearch is supplemented with the firm's centralized analyst team throughout the entire process.

The team will sell a stock if one of the following occurs: full accretion of catalyst into relevant metrics or stock price, or failure ofinitial catalyst. A stock will be reviewed if it declines 10% from cost or 15% from its 52-week high.

The portfolio consists of 50 to 70 holdings with no one single position exceeding the maximum of 5% or 1.5x the index weight atcost. Sector weights are restricted to fall between 50% and 150% relative to the benchmark sector (up to +/- 10% for smallersectors). Cash is limited to 5%, ADRs are capped at 15%, and portfolio turnover averages 80%-100%.

8February 19, 2014

MERCER

Strategy ProfileMercer Evaluation Summary

Factor Rating(-, =, + or ++)

Comments

Idea Generation + The generation of ideas is the responsibility of each team member, but ideas are approved by Rosenblatt and Barker. Thisgrowth oriented investment team seeks stocks with accelerating growth metrics, as opposed to those that meet certain highgrowth hurdle rates, and very specific quality metrics. This 'second derivative' approach to growth investing, while reflective of aforward looking, non-consensus oriented investment philosophy, does not necessarily translate into a defensive investmentstrategy on a consistent basis. Neuberger has restructured its large cap growth team over the last several years to generatemore investment ideas for Rosenblatt and Barker to consider and lessen its reliance on the firm's centralized buy-side analysts(used primarily for industry overviews), but has encountered some personnel issues in doing so. On the positive side, theinvestment process is considered sound and research is focused on developing a non-consensus edge. We think ideageneration benefits from the team being specifically dedicated to this one strategy and from the insulation of key team membersfrom most non-investment distractions.

PortfolioConstruction

+ The portfolio is well diversified but is subject to the sector tilts of the growth benchmark (Neuberger generally refrains fromtaking large sector bets relative to the index). Positions are weighted based on index weight plus (or minus) conviction. NeillGroom, as portfolio risk manager, is responsible for tracking the portfolio's risk exposures on a daily basis. BARRA is used toanalyze ex-ante tracking error and the portfolio's Active Share is explicitly managed but not particularly high. Groom's dailydashboard review monitors multiple exposures versus the benchmark and he works very closely with the portfolio managers. Aquarterly portfolio review is conducted which focuses on strategy, style, performance attribution, and risk analysis, mostly for thebenefit of the firm's head of portfolio analysis and equities CIO.

Implementation + Trading resources are sophisticated and capacity/liquidity issues are not a concern at this time.BusinessManagement

+ In December 2008, following the bankruptcy of Lehman, a group of senior investment and management professionals agreed toacquire a majority interest in Lehman's Investment Management Division. We viewed this as a positive development forinvestors in Neuberger Berman and Lehman Brothers funds as the alignment of interests and the longer-term direction of thebusiness was made more stable and clear. Since then, the firm has demonstrated its ability to operate as a stand alone entitywhile retaining talent within the firm and is moving toward 100% employee ownership over the next three years. The firmremains in a strong financial position with revenues from approximately $214 billion in assets under management. Neuberger'scompensation scheme includes a deferred element of up to 25% that, for the Disciplined Large Cap Growth investment team, isinvested in either Neuberger shares or this strategy.

Overall Rating(A, B+, B or C)

B+

The insistence on both free cash flow yield and operating income growth ensure some portfolio emphasis on quality over time, but the strategy is byits nature somewhat chameleonic (i.e., not always defensive) as the team seeks companies with acceleration of a key business metric that can differfrom company to company. Growth and seasoning of the team over the years has added depth to Neuberger's research capabilities. Personnel andstructural changes have been somewhat disruptive, albeit beneficial. While the team leverages the Neuberger's centralized buy-side analyst team tosupplement its research, this group is not utilized for idea generation. The team is knowledgeable and Rosenblatt and Barker provide solid but notnecessarily passionate leadership. Moreover, the support provided by the organization allows the team the luxury of singularity of focus and aminimization of distractions within the context of a firm with an expanding product lineup.

AdditionalObservations

The strategy is considered to be traditional growth and has the potential to perform well in most market environments. Those favoring lower quality orsmaller cap names within the Russell 1000 Growth Index may present performance headwinds for Neuberger.

9February 19, 2014

MERCER

Performance Analysis

10February 19, 2014

The market benchmark ranked high in the universe; thiswas a difficult environment for active managers in this

space

MERCER


11February 19, 2014

The market benchmark ranked high in the universe; thiswas a difficult environment for active managers in this

space

MERCER


12February 19, 2014

Risk-adjusted return as expected.Strategy exhibited lower risk,

though with lower return.


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'Value' Factors 'Growth' Factors Other Style Factors

Sep 2013 vs Historical Tilt Range - Sep 2007 to Sep 2013 (21)Neuberger Berman vs. Russell 1000 Growth

Holdings Based Style Analysis

• Portfolio exposures generally in line with philosophy

• Low Gearing (financial leverage) indicates conservative balance sheet

• Low Sustainable Growth and RoE indicate portfolio holds stocks whose financial results have not

been strong (and may be poised for an improvement)

• Moderate exposure to forecast earnings growth consistent with buying stocks where market does not

recognize future growth

• Low Cash Flow yield is out of character, but most recent period shows this metric increasing

MERCER

Transition Costs & Risks

Visible Commissions

Taxes

Not Visible Bid/Ask Spreads

Market Impact

Market Movement

(a.k.a., Tracking Error or

Opportunity Cost)

Implicit Costs(Price Movement

or Degradation)

Explicit Costs(Fees)

Known costs –Negotiable(excluding taxes)

Uncertain – Canonly be managed

Can be estimated

Generally greaterthan explicit costs

Uncertain – Cannotbe managed(potentially largestcosts)

Total Cost for US Large Cap Transition 12bp ($408,000) +/- 20bp

(4 ~ 12 bps)

(3 ~ 6 bps)

( +/- 15 ~ 25 bps, @1 std.dev.)


Multi-Manager Diversification

MERCER 16

Alternative Manager Comparison

Rating StrategyAssets (M) Inception Beta

(10 Year Hist)Neuberger Berman B+ 6,812 1987 0.91Edgewood A(T) 8,969 1974 1.01Montag & Caldwell B+ 13,138 1945 0.86Polen B+(T) 4,987 1989 0.84HS B+(T) 2,392 2007 0.88*Stralem B+(T) 3,409 1966 0.76DSM A(T) 4,661 2002 1.03Vontobel B+(T) 1,687 1990 0.69

*5 year beta

MERCER 17


MERCER 18


MERCER 19


MERCER 20


MERCER 21


MERCER

Correlation of Excess Returns vs. Russell 1000 Growth in $US (before fees) over 10 yrs ending December-13(quarterly calculations)

Notes:Correlation is shown in the right hand side of the table.Risk Reduction is shown in the left hand side of the table.Risk Reduction is defined as the reduction in tracking error from diversification when using a 50:50 mix of the two managers.

22

Alternative Manager ComparisonFit with Existing Managers

SANLCG1 WECLCG1 NBRLCG2 EMCLCG MONLCG PLNLCG SRLLCG DSMLCG VONLCV1

Sands CapitalLarge Cap Growth SANLCG1 0.43 -0.25 0.15 -0.40 -0.13 -0.57 0.17 -0.49WellingtonOpportunisticGrowth

WECLCG1 -1.02 0.04 -0.01 -0.29 -0.36 -0.35 0.26 -0.56

Neuberger Berman- Large CapDisciplinedGrowth

NBRLCG2 -2.08 -1.29 0.19 0.42 0.29 0.47 0.30 0.04

Edgewood -Institutional LargeCap Growth

EMCLCG -1.64 -1.62 -1.08 0.06 0.12 -0.21 0.39 -0.25

Montag - LargeCap Growth MONLCG -2.55 -1.95 -0.67 -1.34 0.34 0.54 0.19 0.20

Polen - Large CapGrowth Equity PLNLCG -2.35 -2.41 -0.94 -1.45 -0.91 0.27 0.00 0.44

Stralem - US LargeCap EquityStrategy

SRLLCG -3.91 -2.50 -0.71 -2.23 -0.64 -1.23 0.04 0.60

DSM - Large CapGrowth Equity DSMLCG -1.45 -1.04 -0.86 -0.86 -1.05 -1.54 -1.53 -0.27

Vontobel (US) - USEquity VONLCV1 -4.17 -3.32 -1.48 -2.54 -1.27 -1.03 -0.76 -2.35

23February 19, 2014

Appendix

MERCER 24

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MERCER 25

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MERCER 26

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